Since the start of the year, these momentum stocks have been hot, but they took a breather in the past couple months, falling off their highs. Now it's time to watch for signs that they can break out again. A rally above short-term resistance levels could signal that the pullback is over and that the next up wave is commencing.
Shares of Momo are up almost 300% from where they traded one year ago, and that is after the stock has been dropping for for the past six weeks. Momo peaked at $45.95 in May, and it has made a series of lower swing highs since. Traders will be watching for renewed signs of strength indicating that the pullback may be over and that another move higher is commencing.
A rally above $40 could be a trigger. That was the last swing high in June, so a rally above it would create a higher swing high – a requirement for an uptrend. If that occurs, a stop-loss order could be placed below the June low of $35.02 or alternatively below $36.11. High-momentum stocks can run, so it is wise to maximize gains with a trailing stop-loss. During the last two waves higher, a 30-day simple moving average could have been used to capture most of the rally and trigger an exit (when the price dropped below it). Average true range (ATR) stops are also useful indicators to use as a trailing stop-loss (where the stop-loss trails the price by the ATR, multiplied by a value appropriate for the stock). (For more, see: A Logical Method of Stop Placement.)
Yum China Holdings is on the verge of breaking out from a small triangle pattern, following a strong rally that extends back to April. The breakout point is $40.30, which the price briefly crossed on July 3. The triangle is approximately $4 in height, which indicates a conservative upside price target of $44.30 if the price breaks out. With a high-momentum stock, a $4 profit target (approximately 10%) may leave money on the table.
A 30-day moving average would have captured the entire rally since April, before finally getting the trader out for a gain of more than 40%. A simple moving average may work again, but typically, a volatility-based indicator such as an ATR stop works better as a trailing stop-loss. An initial stop-loss could be placed below the July 29 swing low of $38.42 if the upside breakout materializes. (See also: Is Yum China a Better Bet for Investors Than Yum! Brands?)
Shares of 58.com have had several strong pushes to the upside since the start of the year. These rallies have been eating into the significant price declines seen over the past couple of years. After a volatile May and June, where the price whipsawed between $39.68 and $47.38, the price consolidated at the end of June. Traders should watch for a breakout and especially a closing price above $44.74, which is the top of the consolidation. If the price can keep moving higher, the stock could see another strong buying push.
One possible problem is having to place the stop-loss below $40, which creates a fair bit of risk on this trade: close to 12%. It will take a really strong rally to compensate for that risk, so it may be better to a wait for an alternate trade setup or place a stop-loss near $42.25 instead (although this means a higher chance of being stopped out). A moving average has worked okay as an exit on the last few trades, but it is not ideal. In this case, a profit target between $53 and $54 may work better. That target is based on the strength of the recent uptrend and prior resistance areas. (For more, see: Trailing-Stop Techniques.)
The Bottom Line
These stocks had lots of momentum but have stumbled recently. If they can regain their footing and push above short-term resistance, that could create another strong buying push. Trends change, so traders should utilize a stop-loss to help manage risk. Also, it is advisable only to risk a small percentage of account capital on any single trade. (For additional reading, check out: The Elements of a Perfect Momentum Trade.)
Charts courtesy of StockCharts.com. Disclosure: The author does not have positions in the stocks mentioned.